On January 12, the day the price of Bitcoin dropped from $41,000 to $30,500, over $2.5 billion worth of futures contracts were liquidated. The derivatives market, which was extremely overleveraged and overcrowded, saw a massive reset.
Following the shakeout, a pseudonymous trader known as “Byzantine General” said that there is a chance the “bottom” is in.
Strong arguments for a Bitcoin bottom
Percentage-wise, the sudden drop from $41,000 to $30,500 was not as big as corrections in previous bull cycles.
Bitcoin typically sees 30% corrections during a prolonged bull market, and compared to historical pullbacks, a 20% drop is relatively small.
However, the correction on January 12 was significant because it gave the derivatives market a much-needed reset.
Before the drop, the Bitcoin futures market was incredibly overheated. The market was overwhelmingly dominated by buyers and long contract holders.
The funding rate of futures contracts reached historical highs, which indicates that the market is heavily overcrowded with buyers.
When the market gets concentrated to this extent, a long squeeze often occurs. A long squeeze happens when traders in the futures market that use leverage to initiate larger trades get liquidated one after the other.
Cascading liquidations can cause Bitcoin to drop intensely within a short period, as seen on March 13, 2020, when BTC dropped to as low as $3,596 on BitMEX.
Considering that $2.5 billion worth of contracts were liquidated and exchanges saw record-high volumes, the trader said that a bottom could be in. He wrote:
“I just realized that 2 days ago when we had that big drop there was almost 2.5 billi in aggregated liquidations. That’s a record baby. This was also the daily with the highest aggregated spot AND perps volume ever recorded. Not just exchange volume, but also total transaction volume in USD was historically high. Man, I’m starting to think the bottom is in.”
Although the drop was only 20%, and it is smaller than historical corrections, the trader also explained that the size of the drop is less relevant in the context of a shakeout.
In the case of the Bitcoin correction on January 12, the price swing caused billions of dollars worth of contracts to get obliterated. Even though the drop itself was not as big, it immensely impacted the futures market and flushed out most derivatives exchanges.
The volume of major exchanges, like Coinbase, exceeded their Q1 2020 volume on that single day, demonstrating the volatility during that period.
What comes next?
In the near future, as it happens after every major correction, Bitcoin is likely to see low volatility.
The ideal scenario for BTC is to consolidate for several days with low volatility for the markets to cool down.
If the derivatives market becomes less overheated as a result, the probability of a prolonged bull run increases.